CIR vs. CA & A.

SORIANO CORP (1999, MARTINEZ, J) FACTS: In 1930, Don Andres Soriano, a citizen and resident of the United States, formed the corporation "A. Soriano Y Cia", predecessor of ANSCOR, with a P1,000,000.00 capitalization divided into 10,000 common shares at a par value of P100/share. ANSCOR is wholly owned and controlled by the family of Don Andres, who are all non-resident aliens. On 1945, ANSCOR's authorized capital stock was increased to P2,500,000.00 divided into 25,000 common shares with the same par value of the additional 15,000 shares, only 10,000 was issued which were all subscribed by Don Andres. By 1947, ANSCOR declared stock dividends. Other stock dividend declarations were made between 1949 and 1963. On 1964 Don Andres died. As of that date, the records revealed that he has a total shareholdings of 185,154 shares. One-half of that shareholdings were transferred to his wife, Doa Carmen Soriano, as her conjugal share. The other half formed part of his estate. After Don Andres died, ANSCOR increased its capital stock to P20M and in 1966 further increased it to P30M. In the same year, stock dividends worth 46,290 and 46,287 shares were respectively received by the Don Andres estate and Doa Carmen from ANSCOR. Hence, increasing their accumulated shareholdings to 138,867 and 138,864 common shares each. On 1968, ANSCOR reclassified its existing 300,000 common shares into 150,000 common and 150,000 preferred shares. Doa Carmen exchanged her whole 138,864 common shares for 138,860 of the newly reclassified preferred shares. The estate of Don Andres in turn, exchanged 11,140 of its common shares, for the remaining 11,140 preferred shares, thus reducing its (the estate) common shares to 127,727. On June 1968, ANSCOR redeemed 28,000 common shares from the Don Andres' estate. By November 1968, the Board further increased ANSCOR's capital stock to P75M divided into 150,000 preferred shares and 600,000 common shares. About a year later, ANSCOR again redeemed 80,000 common shares from the Don Andres' estate, further reducing the latter's common shareholdings to 19,727. In 1973, after examining ANSCOR's books of account and records, Revenue examiners issued a report proposing that ANSCOR be assessed for deficiency withholding tax-at-source for the year 1968 and the second quarter of 1969 based on the transactions of exchange and redemption of stocks. The BIR made the corresponding assessments despite the claim of ANSCOR that it availed of the tax amnesty under Presidential Decree 23 which were amended by P.D.'s 67 and 157. CIR: ruled that ANSCOR was liable for the tax. ANSCOR's subsequent protest on the assessments was denied in 1983 by petitioner. CTA: reversed CIRs ruling, CA: Affirmed CTA The bone of contention is the interpretation and application of Section 83(b) of the 1939 Revenue Act which provides: Sec. 83. Distribution of dividends or assets by corporations. (b) Stock dividends A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or

redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent it represents a distribution of earnings or profits accumulated after March first, nineteen hundred and thirteen.
ISSUE: WON ANSCORs redemption of stocks from its stockholder as well as the exchange of common with preferred shares can be considered as essentially equivalent to the distribution of taxable dividend, making the proceeds thereof taxable under the provisions of the above-quoted law. HELD/RATIO: The proceeds of its redemption of stock dividends may be deemed as taxable dividends

General Rule

The general rule states that: A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. Stock dividends represent capital and do not constitute income to its recipient. The mere issuance thereof is not yet subject to income tax as they are nothing but an enrichment through increase in value of capital investment. As capital, the stock dividends postpone the realization of profits because the fund represented by the new stock has been transferred from surplus to capital and no longer available for actual distribution. Stock dividends issued by the corporation, are considered unrealized gain. Before the realization, stock dividends are nothing but a representation of an interest in the corporate properties. The Exception The exception states that: However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent it represents a distribution of earnings or profits accumulated after March first, nineteen hundred and thirteen. The exempting clause was added because corporations found a loophole in the original provision. Corporate earnings would be distributed under the guise of its initial capitalization by declaring the stock dividends previously issued and later redeem said dividends by paying cash to the stockholder. This process of issuance-redemption amounts to a distribution of taxable cash dividends which was just delayed so as to escape the tax. The exempting clause was added provides that when the redemption or cancellation of stock dividends, depending on the time and manner it was made is essentially equivalent to a distribution of taxable dividends, it makes the proceeds thereof taxable income to the extent it represents profits. The exception was designed to prevent the issuance and cancellation or redemption of stock dividends, which is fundamentally not taxable, from being made use of as a device for the actual distribution of cash dividends, which is taxable. Although redemption and cancellation are generally considered capital transactions, as such, they are not subject to tax. However, it does not necessarily mean that a shareholder may not realize a taxable gain from such transactions. Simply put, depending on the circumstances, the proceeds of redemption of stock dividends are essentially distribution of cash dividends, which when paid becomes the absolute property of the stockholder. Thereafter, the latter becomes the exclusive owner thereof and can exercise the freedom of choice. Having realized gain from that redemption, the income earner cannot escape income tax.

For the a) b) c)

exempting clause to apply, it is indispensable that: there is redemption1 or cancellation; the transaction involves stock dividends and the time and manner of the transaction makes it essentially equivalent to a distribution of taxable dividends. Of these, the third is the most important. With regards to the first element, ANSCOR redeemed shares of stocks from a stockholder (Don Andres) twice (28,000 and 80,000 common shares). But where did the shares redeemed come from? If its source is the initial capital subscriptions upon establishment of the corporation, its redemption is not considered taxable, as it is not income but a mere return of capital. However, if the redeemed shares are from the subsequent stock dividend declarations, the proceeds of the redemption is additional wealth, and is taxable because it is a gain. With regard to the second element, at the time of the redemption, 108,000 shares redeemed from the estate. But only 25,247.5 of that constituted the original common shares owned by the estate. This means the balance of 82,752.5 must have come from stock dividends. With respect to the third requisite, not all redemptions of stock dividends are taxable. Such depends on such time and in such manner the redemption was conducted. Whether the amount distributed in the redemption should be treated as the equivalent of a taxable dividend is a question of fact, which is determinable on the basis of the particular facts of the transaction in question. On this aspect, American courts developed certain recognized criteria, which include the following: 1. the presence or absence of real business purpose, 2. the amount of earnings and profits available for the declaration of a regular dividend and the corporations past record with respect to the declaration of dividends, 3. the effect of the distribution as compared with the declaration of regular dividend, 4. the lapse of time between issuance and redemption, 5. the presence of a substantial surplus and a generous supply of cash which invites suspicion as does a meager policy in relation both to current earnings and accumulated surplus. ANSCOR redeemed stock dividends issued just 2 to 3 years earlier. The time alone that lapsed from the issuance to the redemption is not sufficient to determine taxability. Factual circumstances must be considered as to the manner of the issuance and the redemption. It is necessary to determine the net effect of the transaction between the shareholder-income taxpayer and the acquiring (redeeming) corporation. The net effect test is not evidence or testimony to be considered; it is rather an inference to be drawn or a conclusion to be reached. ANSCOR invoked two reasons to justify the redemptions (1) the alleged filipinization program and (2) the reduction of foreign exchange remittances in case cash dividends are declared. The two purposes invoked by ANSCOR under the facts of this case are no excuse for its tax liability. First, the alleged filipinization plan cannot be considered legitimate as it was only implemented after the redemption, when the BIR started making assessments on the proceeds of the redemption. In any case, the Board Resolutions authorizing the redemptions state only one purpose reduction of foreign exchange remittances in case cash dividends are declared. Even this purpose can be given credence. Records show that despite the existence of enormous corporate profits no cash dividend was ever declared by ANSCOR from 1945 until the BIR started making assessments in the early 1970s. Since no cash dividends was issued for about three decades, this circumstance negates the legitimacy of ANSCORs alleged purposes.
1

Redemption is repurchase, a reacquisition of stock by a corporation which issued the stock in exchange for property, whether or not the acquired stock is cancelled, retired or held in the treasury. In redemption, the corporation gets back some of its stock, distributes cash or property to the shareholder in payment for the stock, and continues in business as before.

The existence of legitimate business purposes in support of the redemption of stock dividends is immaterial in income taxation. It has no relevance in determining dividend equivalence. The test of taxability under the exempting clause, when it provides such time and manner as would make the redemption essentially equivalent to the distribution of a taxable dividend, is whether the redemption resulted into a flow of wealth. If no wealth is realized from the redemption, there may not be a dividend equivalence treatment. The presence or absence of "genuine business purposes" may be material with respect to the issuance or declaration of stock dividends but not on its subsequent redemption. The issuance and the redemption of stocks are two different transactions. Although the existence of legitimate corporate purposes may justify a corporation's acquisition of its own shares under Section 41 of the Corporation Code, 115 such purposes cannot excuse the stockholder from the effects of taxation arising from the redemption. If the issuance of stock dividends is part of a tax evasion plan and thus, without legitimate business reasons, the redemption becomes suspicious which exempting clause. The substance of the whole transaction, not its form, usually controls the tax consequences.116 The test of taxability under the exempting clause of Section 83(b) is, whether income was realized through the redemption of stock dividends. The redemption converts into money the stock dividends which become a realized profit or gain and consequently, the stockholders separate property. Profits derived from the capital invested cannot escape income tax. As realized income, the proceeds of the redeemed stock dividends can be reached by income taxation regardless of the existence of any business purpose for the redemption. Otherwise, the Bureau of Internal Revenue (BIR) would be pestered with instances in determining the legitimacy of business reasons that every income earner may interposed. It is not administratively feasible and cannot therefore be allowed. After considering the manner and the circumstances by which the issuance and redemption of stock dividends were made, there is no other conclusion but that the proceeds thereof are essentially considered equivalent to a distribution of taxable dividends. As taxable dividend under Section 83(b), it is part of the entire income subject to tax under Section 22 in relation to Section 21 of the 1939 Code. Moreover, under Section 29(a) of said Code, dividends are included in gross income. As income, it is subject to income tax which is required to be withheld at source. The 1997 Tax Code may have altered the situation but it does not change this disposition. DISPOSITIVE: The decision of the Court of Appeals is MODIFIED in that ANSCORs redemption of 82,752.5 stock dividends is herein considered as essentially equivalent to a distribution of taxable dividends for which it is LIABLE for the withholding tax-at-source. The decision is AFFIRMED in all other respects.